Farhan Qureshi (R. Madhavan), Raju Rastogi (Sharman Joshi) and Ranchoddas Shamaldas "Rancho" Chanchad (Aamir Khan) are three engineering students who share a room in the residence of Imperial College of Engineering (ICE). Farhan is studying engineering to pursue his father's wishes over his own wish — to become a wildlife photographer. Raju is studying to raise his family's fortunes and get them out of poverty. On the other hand, Rancho studies for his simple passion in machines and devices. Rancho believes that success in studying is not achieved by solely memorizing definitions given by textbooks or professors, but by understanding and applying the concepts. He believes that one should follow excellence, not success, as success will come by itself if excellence is followed.
However, this different approach is sneered upon by the faculties, including the dean of the college, Professor Viru "Virus" Sahastrabudhhe (Boman Irani). In contrast, Virus' favorite student, Chatur "Silencer" Ramalingam, (Omi Vaidya) believes in mindless memorizing over understanding, in order to reach his goals of corporate and social status. Meanwhile, Rancho falls in love with Virus' medical student daughter Pia (Kareena Kapoor) when he, Raju and Farhan accidentally crash her sister's wedding banquet to obtain a free meal, which infuriates Virus. Virus labels Rancho and his friends as "idiots" and continually attempts to break Rancho's friendship with Farhan and Raju.
Things further escalate when the three friends drunkenly break into Virus's house one night to allow Rancho to confess his love to Pia, and urinate on the front door before fleeing. The next day, Virus threatens to rusticate Raju unless he squeals on Rancho. Not wanting to betray his friend or let down his family, Raju attempts suicide and ends up in a coma. However, with two months of extensive care from his mother, Rancho, Farhan, and Pia, he makes a full recovery. Following his hard-won recovery, Raju discards his fear of the future. Encouraged by Rancho, both Raju and Farhan gain courage to do what they were afraid to do before. Raju takes a frank approach in an interview for a corporate job, while Farhan convinces his parents to allow him to pursue his love of wildlife photography, both successful in their endeavors.
When Virus discovers that Raju successfully obtained a job offer, he conspires to prevent him from getting the job by creating an exam paper so tough that will deliberately fail Raju. When Pia learns of his plan, she helps Rancho and Farhan by providing them with the keys to her father's office. They bring a xeroxed copy of the exam to Raju, but Raju, with his newfound attitude, calmy throws the paper away. However, Virus catches them and expels them on the spot. Pia angrily confronts him, revealing that his son, Pia's brother, committed suicide when he could not get into ICE, like Virus demanded, even though he had no interest in engineering and instead wished to be a writer. After revealing this, Pia exiles herself by fleeing to her hospital where she is a student. Later that same night, Pia's pregnant older sister Mona (Mona Singh) goes into labor. A heavy rainstorm cuts all power and floods the streets, making it impossible for the ambulance to reach Mona, and Pia is stuck at her hospital, where she had fled. Rancho, Farhan and Raju come to the rescue, along with other students from ICE. Over phone and webcam, Pia instructs Rancho to deliver the baby via VOIP. After the baby is apparently stillborn, Rancho resuscitates the baby by leading the students in saying "All is well". Virus finally reconciles with Rancho and his friends, and allows them to stay for their final exams.
Their story is framed as intermittent flashbacks from the present day, ten years after Chatur bet that he'd become more successful than Rancho. Having lost contact with Rancho, who disappeared during the graduation party and went into seclusion, after five years, Raju and Farhan begin a journey to find him. They are joined by Chatur, now a wealthy and successful professional in the USA, who is looking to seal a deal with a famous scientist and prospective business associate named Phunsukh Wangdu. When they find Rancho's house inShimla, they find a completely different man: the real Ranchoddas Chanchad (Jaaved Jaffrey).
Forcing the new man to surrender his identity, they come to know that their friend was a destitute servant boy "Chhote" who loved learning, while he, the real Rancho, disliked study. After seeing the boy's intelligence, the family agreed to let the servant boy study in Rancho's place instead of laboring. In return, the real Rancho would pocket his qualifications and after graduating, the servant boy will cease all contact. The real Rancho reveals that Chhote is now a schoolteacher in Ladakh. At the same time, they find out that, without Rancho, Pia decided to marry the same price-obsessed banker, Suhas, that Rancho initially talked her into dumping, and they go to rescue her from the wedding.
Raju and Farhan find Pia and arrive at Rancho’s school. Pia and the fake Rancho rekindle their love, while Chatur mocks Rancho for becoming a lowly schoolteacher. He asks Rancho to sign a "Declaration of Defeat" document. When Rancho's friends ask what his real name is, he reveals that he is actually Phunsukh Wangdu himself. Chatur finds out about this and is horrified; he accepts his defeat and pleads his case with Phunsukh, to establish the business relationship he was after as the gang runs off into the sunset with Chatur in pursuit and as the credits roll in.